Sumitomo, Sakura talk bank alliance

CBS.MarketWatch.com

TOKYO (CBS.MW) -- Sumitomo Bank and Sakura Bank, major lenders to two of Japan's biggest industrial groups, announced Thursday evening a broad alliance that aims to create the world's second-largest banking group with more than $925 billion in assets.

Reflecting a sweeping realignment within a Japanese banking industry that's trying to cope with stiff global competition as it crawls out from under piles of bad debt, Sumitomo and Sakura said they intend to take equity stakes in each other by next March before merging operations by April 2002.

Theirs is the third Japanese mega-bank plan unveiled in less than two months. But what may be more significant about a Sumitomo-Sakura alliance than either size or the trend it highlights is that this marriage may also spawn major realignments between and among the banks' blue-chip corporate clients, analysts said.

Industrial Bank of Japan, Fuji Bank and Dai-Ichi Kangyo Bank started the ball rolling August 20, saying they'll coalesce into a humongous financial group next year. Copying the troika's plan for a joint holding company, Tokai Bank and Asahi Bank, another pair of big "city" (commercial) banks, got into act last week.

Especially since then Sakura Bank, which belongs to the 300-year-old Mitsui group and boasts an extensive retail network, became a hot subject of merger rumors and its shares surged.

Sakura's stock gained 100 yen Thursday on the news that it was negotiating with Sumitomo to close at 1000. Sumitomo shares
subjy
jumped 170 yen to 1725.

Rival corporate families But if Sakura was seen as next in line for a tie-up, its partnering with Sumitomo comes as something of a surprise.

"The view was that a realignment joining two banks at the core of two rival Japanese corporate families would be too difficult, too painful," said James Fiorillo, senior banking analyst at ING Baring Securities.

But there's a logic that stems from the difficult, perhaps painful choice Sakura was facing. Japan's fifth-largest bank has seen its fundamental health slowly but steadily deteriorate. Real-estate prices are still falling here, prolonging the pain of writing off billions of dollars in bad loans. Deregulation, tougher foreign competition in this market and consolidation within the banking sector intensified the threat to Sakura's viability.

One option for Sakura was to sharpen its focus completely on retail banking. With 15 million ordinary deposit accounts, Sakura has the largest retail customer base in Japan. An alliance with another retail giant -- speculation keyed on Sanwa Bank -- could've created a formidable competitor to the domestic-oriented match of Tokai and Asahi, whose assets when pooled will total 59 trillion yen ($551.4 billion). See related story.

The alternative: going the global mega-bank route, patterned on the IBJ-Fuji-DKB alliance, whose combined financial muscle will flex assets of 141 trillion yen ($1.32 trillion). The world's biggest bank today is Deutsche Bank AG of Germany
dtbky
weighing in with $915 billion in assets as of June. See related story.

"Sakura's problem in choosing the retail route was the Mitsui group companies -- how do you give that business up?" said Fiorillo. "But on the mega-bank side, there were huge missing pieces, like asset management and investment banking."

Sakura on Sept. 30 agreed to a securities-marketing joint venture with Deutsche Securities, a tie-up that fell short of a comprehensive alliance the bank was trying to work out with Deutsche Bank, according to industry sources.

A Sakura-Sumitomo alliance pools assets of 99 trillion yen ($925 billion), more than Deutsche but less than IBJ-Fuji-DKB. Banks of that size are hard to push around, but rival banks from the United States and Europe have shown that competitiveness also depends on generating returns on equity upwards of 20 percent or so, and on investing heavily in information technology.

ROE and IT are intertwined and Japanese banks lag in both. Their challenge will be to get ROE up to 15 percent from current levels of 7 to 9 percent. Part of that leap, analysts say, can be accomplished by pricing loans properly, which requires know-how but also state-of-the-art hardware and software.

Investors in Japanese bank shares should pay as much attention to this as they do to figures Sakura and Sumitomo toss out about how many jobs will be cut (6300 before the merger and 3000 after it, from a combined staff of 31,300) and bank branches closed (151 domestic and 32 overseas outlets from a total of 807). Cost cutting matters, but so does how the savings will be applied.

More obstacles, more consolidation

Two other looming obstacles are dud loans and managing the alliance. Sakura and Sumitomo had a combined 3.8 trillion yen in problem loans as of the end of March. The banks aim to reduce their annual loan loss charges to below 200 billion yen after the planned merger in April 2002.

Navigating the path to the merger and making it work will be complicated, considering the personal relationships and distinct cultures of the more conservative and cohesive Sumitomo group and the bolder, more loosely aligned Mitsui group. (Sakura Bank is the product of the 1990 merger of Mitsui and Taiyo Kobe banks.)

But as the landscape shifts, the nonfinancial realignments will become as important as the financial ones. Said Fiorillo: "There are potentially huge M&A opportunities within the Sumitomo and Mitsui groups that these banks will be able to handle."

Each bank is responsible for about 10 percent of the outstanding loans to group companies. Companies within the Mitsui group include Fuji Photo Film Co.
FUJIY, -1.65%
retailer Mitsukoshi Ltd., Toshiba Corp, and general trading house Mitsui & Co.
mitsui
The Sumitomo group includes Asahi Breweries Ltd., NEC Corp.
"
Yamanouchi Pharmaceutical and a heap of companies with the Sumitomo name across all industries.

Little more than a year ago, Japan had 21 main banks. Consolidation is pointing toward half a dozen key players.

"The pressure on the remaining banks has clearly risen," said Ken Okamura, strategist at Dresdner Kleinwort Benson, "Sanwa, Bank of Tokyo-Mitsubishi
MBK, -0.60%
and even Tokai-Asahi cannot sit back and allow the wave to pass them by."

Some analysts speculate the Tokai-Asahi pairing may soon become a threesome with Daiwa Bank. The market's focus is also zooming in on Japanese trust banks.

Chuo Trust and Mitsui Trust have embarked on an alliance. The five other major trust banks -- Mitsubishi, Sumitomo, Yasuda, Toyo and Nippon -- have affiliations with the city banks and will be hard-pressed to avoid the consolidation wave.

Everybody is invited to this dance. To say that change is afoot is an understatement.

Intraday Data provided by SIX Financial Information and subject to terms of use. Historical and current end-of-day data provided by SIX Financial Information. All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only. Intraday data delayed at least 15 minutes or per exchange requirements.